The Budget Deficit Crisis Puzzle

The country faces a serious crisis in the form of a manufactured crisis over the budget deficit. This is a crisis because concerns over the size of the budget deficit are preventing the government from taking the steps needed to reduce the unemployment rate. This creates the absurd situation where we have millions of people who are unemployed, not because of their own lack of skills or unwillingness to work, but because people like Alan Greenspan and Ben Bernanke mismanaged the economy.

The basic story is very simple and one that we have known since Keynes. We need to create demand in the economy. The problem is that, as a society, we are not spending enough to keep the economy running at capacity. Prior to the collapse of the housing bubble, the economy was driven by booms in both residential and nonresidential construction. It was also driven by a consumption boom that was in turn fueled by the trillions of dollars of ephemeral housing bubble wealth.

With the collapse of the bubbles, both residential and nonresidential construction have collapsed. There is a huge amount of excess supply in both markets, which will leave construction badly depressed for years into the future. Together, we have lost well over $500 billion in annual demand from the construction sector. In addition, the loss of the ephemeral wealth created by the bubble has sent consumption plummeting, leading to the loss of an additional $500 billion a year in annual demand.

The hole from the collapse of construction and the falloff in consumption is more than $1 trillion a year. The government is the only force that can make up this demand. However, this means running large deficits. To boost the economy, the government must spend much more than it taxes.

The stimulus approved by Congress last year was a step in the right direction this way, but it was much too small. After making adjustments for some technical tax fixes and pulling out spending for later years, the stimulus ended up being around $300 billion a year. Even this exaggerates the impact of the government sector, since close to half of the stimulus is being offset by cutbacks and tax increases at the state and local level.

The answer in this situation should be simple: more stimulus. But the deficit hawks have gone on the warpath insisting that we have to start worrying about bringing the deficit down. They have filled the airwaves, print media and cyberspace with solemn pronouncements about how the deficit threatens to impose an ungodly burden on our children.

This is of course complete nonsense. Larger deficits in the current economic environment will only increase output and employment. In other words, larger deficits will put many of our children's parents back to work. Larger deficits will increase the likelihood that parents can keep their homes and provide their children with the health care, clothing, and other necessities for a decent upbringing. But the deficit hawks would rather see our children suffer so that we can have smaller deficits.

In spite of the deficit hawks' whining, history and financial markets tell us that the deficit and debt levels that we are currently seeing are not a serious problem. The current projections show that, even ten years out on our current course, the ratio of debt to GDP will be just over 90 percent. The ratio of debt to GDP was over 110 percent after World War II. Instead of impoverishing the children of that era, the three decades following World War II saw the most rapid increase in living standards in the country's history.

We can also look to Japan, which now has a debt to GDP ratio of more than 180 percent. Investors are not running from Japanese debt. They are willing to hold long-term debt at interest rates close to 1.5 percent. In our own case, the 3.7 percent interest rate on long-term Treasury bonds remains near a historic low.

The story is that we are forcing people to be out of work - unable to properly care for their children - because people like billionaire investment banker Peter Peterson and his followers are able to buy their way into and dominate the public debate. The reality is that we have an unemployment crisis today, not a deficit crisis. The only crisis related to the deficit is that people with vast sums of money (i.e. the people who wrecked the economy) have been able to use that money to make the deficit into a crisis.

Dean Baker is a macroeconomist and co-director of the Center for Economic and Policy Research in Washington, DC. He previously worked as a senior economist at the Economic Policy Institute and an assistant professor at Bucknell University. He is a regular Truthout columnist and a member of Truthout's Board of Advisers.